A reserve stock split is implemented by certain companies as a strategy to increase their share price. This is the opposite of normal stock splits. In fact, a reserve stock split means a merge in stocks. Stocks are merged in 1 for 10 or 1 for 20 and the end result would be the increase in share price. This is the quickest way to increase a share price.
Why a company would wants to increase their share price?
There is being a several reasons to this. The company may try to avoid being delisted from a certain index. Or it may try to be more attractive to the investors by having a good price on its shares. At certain occasions, companies use reverse splits to reduce the number of share holds, especially those with only a few shares.
1) Avoid Being Delisted
There are certain stock markets which have a lowest stock price like $1. If the price drops below this limit, they give a warning to the company and after a certain period, remove the company from that index. Companies try their best to remain in the indexes and at such grave moments, the best way to improve the share price is to go for a reverse split.
So what exactly happens in s reverse split?
Consider that someone has 1000 shares from a certain company. The share price for that company drops to $0.50; so that the person now has $500 worth of shares. Then the company goes for a 1 for 20 reserve split. The share price goes to $ 10. Now the person has only 50 shares, but his capital remains at $ 500.
So how can a company go for a reserve split?
Normally he decision is taken up by the board of directors. The shareholders have empowered the directors to take that decision. But it is the responsibility of the directors to inform their shareholders prior to the reverse split. Once it is implemented, a ‘D’ is added to the shares for a certain period of time so that the future buyers would know that a reverse split has taken place in that company recently.
In fact, a reverse split is not a good sign for the financial stability of a company. Many companies go for a reverse split only when the share price is dangerously low. A stable company with a good share price has no need to merge its shares to improve the share price arterially.
2) Attract the Investors
Certain institutional investors and mutual funds have a minimum share price on which they can invest. Normally this is $ 5. So if a company has shares below $ 5, then those investors cannot invest on those shares. This is a disadvantage for a company. To improve their price, companies go for a reverse split so that they could increase the price to an attractive level.
Again people are aware of a reverse split and they understand that the current financial situation of the company is not so stable.
3) Reduce Shareholders
Some companies would use a reverse split to reduce the number of shareholders. If we take the previous example, the person who had 1000 shares now has only 50 shares. And there are certain limits to the lowest amount of shares one could have. In most cases the limit is 100. A person could only have a number of shares that could be divided by 100.
So in this case, the person who now holds 50 shares is not eligible to hold shares of that company. So what happens is that the company pays him in cash and buys the shares. Like this the company could get rid of those smaller share holders and sell those shares back to their larger investors.
In whatever way, reverse stock splits are important for companies to survive the stock market. It is important that you implement it at the right time that a reverse stock split can save a company from disaster and drive it towards success. At the same time, a wrong split would bring disinter to a company in just the same way. It all depends on how well the company understands the market and their shareholders.